Washington Irr. & Development Co. v. U.S. (I.R.S.)
| Citation | 751 P.2d 1178,110 Wn.2d 288 |
| Decision Date | 24 March 1988 |
| Docket Number | No. 54084-5,54084-5 |
| Court | United States State Supreme Court of Washington |
| Parties | WASHINGTON IRRIGATION & DEVELOPMENT COMPANY, a Washington corporation, Plaintiff, v. UNITED STATES of America (INTERNAL REVENUE SERVICE), Appellant, and J.C. O'Connor Construction, Inc., a Washington corporation, Defendant, and Rainier National Bank, a national banking association, Respondent. |
Atty. Gen., Roger M. Olsen, Lisa A. Prager, Steven M. Parks, Asst. Attys. Gen., Dept. of Justice, Tax Div., William S. Estabrook, Michael L. Paup, Asst. Attys. Gen., Dept. of Justice, Appellate Section, Washington, D.C., Gene S. Anderson, U.S. Atty., Anastasia K. Dritshulas, Asst. U.S. Atty., Seattle, Wash., for appellant.
Weinrich, Gilmore & Adolph, P.S., Robert J. Adolph, Seattle, Wash., for respondent.
The Washington Irrigation & Development Company (WIDCO) initiated this interpleader action in Lewis County in 1983 to determine to whom it should pay a debt it owed to J.C. O'Connor Construction, Inc. (O'Connor). Claims to the debt had been asserted by the United States Internal Revenue Service (IRS) and Rainier National Bank (Rainier). The IRS and Rainier tried the action to the court and both parties now challenge the trial court's order disbursing the interpleaded funds. We affirm in part and reverse in part.
In October 1980, O'Connor entered into a financing arrangement with Rainier. Under the arrangement, O'Connor presented to Rainier invoices for sums owed O'Connor by its customers. Rainier paid O'Connor 80 percent of the face value of the invoices. The receivables were then paid directly to Rainier to repay the invoice financing as well as other loans Rainier had made to O'Connor. Rainier secured the invoice financing arrangement against O'Connor's present and after-acquired receivables, contract rights, and inventory.
The IRS first acquired a lien on O'Connor's assets in March 1981, when it served on Rainier notices of federal tax liens for O'Connor's unpaid taxes for December 1980 through February 1981. On June 29, 1981, the IRS, Rainier and O'Connor met and worked out a repayment plan for O'Connor's tax debts. The plan, set forth in a written installment agreement executed by the IRS and O'Connor, called for O'Connor to pay the IRS each month from July through December, 1981, the greater of 10 percent of its gross receivables or $10,000 to cover past-due taxes, and to pay current payroll taxes within 2 days of each payroll date. Rainier agreed to transmit to the IRS the payments on back taxes from its collections of O'Connor's receivables. The bank also agreed to continue to advance O'Connor working capital so that it could stay in business. The IRS, for its part, agreed not to levy on any of O'Connor's new receivables.
Rainier sent the IRS $89,425.51 between June 29 and December 31, 1981, and continued to finance O'Connor's operations. The IRS and O'Connor amended the installment agreement in December 1981, reducing O'Connor's minimum monthly payment to $5,000. Accordingly, Rainier sent the IRS $15,000 during the first 3 months of 1982.
In December 1981, O'Connor breached the installment agreement by failing to keep current on its payroll taxes. At the IRS's request, O'Connor authorized the IRS to apply the payments forwarded by Rainier to current taxes instead of to the 1980-81 past-due taxes. Rainier was not notified of O'Connor's breach, or of the change in application of the payments, and continued to send the IRS payments from O'Connor's paid-in invoices. As a result, these payments went to satisfy liabilities for current taxes with respect to which Rainier's security interests would have priority over an IRS tax lien, leaving unpaid the past-due tax liabilities that gave the IRS priority.
In March 1983, O'Connor contracted to sell $500,000 worth of crushed rock to WIDCO. The IRS on June 7, 1983 served a notice of levy on WIDCO demanding $142,000 to satisfy O'Connor's indebtedness for taxes due in the fourth quarter of 1980, and the first, second and fourth quarters of 1982. The IRS previously had filed liens to secure payments of taxes due in these periods. On the same date, the IRS served a similar notice of levy on Rainier. Rainier sent the IRS agent who served the notice of levy to O'Connor's nearby offices, and 2 days later O'Connor paid the IRS $21,702.55 from its accounts at Rainier.
Facing conflicting demands from the IRS and Rainier to the money it owed O'Connor, WIDCO initiated the present interpleader action on June 27, 1983, by depositing with the court the $101,632.99 it then owed O'Connor. Subsequently, in September 1983, WIDCO deposited an additional $141,922.19, reflecting further sums it owed O'Connor. In 1985, however, the trial court awarded to Rainier the excess in the interpleaded fund over the $142,578.46 demanded by the IRS in its notice of levy.
On May 2, 1986, the trial court entered findings of fact and conclusions of law. The trial court determined that the IRS's tax liens for the fourth quarter of 1980 and the first and second quarters of 1982 primed Rainier's security interests, but that Rainier's interests primed the IRS's lien for the fourth quarter of 1982. On May 30, 1986, the court ordered the disbursement of the remaining interpleaded funds, awarding $64,222.99 to the IRS and $78,802.78 to Rainier. The IRS's award included statutory interest accruing from the date of its notice of levy on WIDCO to the date WIDCO filed the interpleader suit.
Both the IRS and Rainier appeal from this order. The parties do not dispute the trial court's determination of lien priorities. Rather, they challenge the manner in which the priority amounts were calculated.
The IRS makes two assignments of error. First, it alleges error in the trial court's failure to include in the IRS's award statutory interest on O'Connor's tax liabilities accruing during the pendency of the interpleader action. Second, it asserts that the trial court erred in excluding evidence relating to O'Connor's tax liabilities for the third quarter of 1980. We affirm the trial court on the first issue, but reverse on the second.
The IRS argues that the federal tax lien laws expressly include in the lien amount interest accrued on taxes past due, without limitations relating to the pendency of judicial proceedings. Rainier asserts that the laws do not authorize recovery of interest accrued during interpleader proceedings, and that equitable principles support the trial court's decision denying the IRS interest accruing during this action.
Section 6321 of the Internal Revenue Code, 26 U.S.C. § 6321 (1982), gives the United States a lien on the property of tax defaulters, in the amount of the tax plus interest, penalties and other additions and costs. Section 6601(a) provides that interest on defaulted tax liabilities "shall be paid for the period from [the date the taxes were due] to the date paid." 26 U.S.C. § 6601(a) (1982).
Against this seemingly straightforward statutory priority, Rainier argues that "in bankruptcy and other insolvency proceedings interest upon claims ceases to accrue at the initiation of the proceedings." In re Boston & Maine Corp., 719 F.2d 493, 495 (1st Cir.1983), cert. denied, 466 U.S. 938, 104 S.Ct. 1913, 80 L.Ed.2d 461 (1984). This rule is properly applied in this case, Rainier argues, to prevent the inequity that would result if the IRS assessed the interest for past-due taxes against other creditors of the defaulted taxpayer who are not to blame for that default.
The IRS argues that this rule is applicable only in bankruptcy and insolvency proceedings, and that because this case "involves neither a bankrupt nor an insolvent", the rule cannot be applied here. In support of this distinction, the IRS cites Zontelli & Sons, Inc. v. Fabyanske, Svoboda & Westra, P.A., 394 N.W.2d 526 (Minn.Ct.App.1986). On facts closely similar to those at issue here (an interpleaded fund subject to competing claims from the IRS and other creditors), the Minnesota Court of Appeals reversed a trial court judgment denying the IRS statutory interest on taxes owed, finding that the equitable principle Rainier asserts in this action has limited applicability to bankruptcy proceedings and cannot override the "explicit and controlling statutory provisions" of the Internal Revenue Code that establish the IRS's right to receive interest. Zontelli, at 530.
We are not persuaded by the reasoning in Zontelli, however. It is well established, not only in bankruptcy and insolvency but in other contexts as well, that interest is not charged against the party owing a debt when the funds owed are in custodia legis. See Wilson v. Wilson, 35 Wash.2d 364, 369, 212 P.2d 1022 (1949); Bank of China v. Wells Fargo Bank & Union Trust Co., 209 F.2d 467, 475-76 (9th Cir.1953) (action "akin to ... interpleader"); Shell Oil Co. v. Jones, 191 F.Supp. 585, 590-91 (S.D.Tex.1960) (interpleader action). This rule applies not only to protect debtors from seeing their debts inflated by interest accrual while the litigative process slowly reaches its conclusion, but also, when the funds held by the court are claimed by competing creditors, to prevent claims carrying a low rate of interest from being overridden by claims that happen to bear a high interest rate. See American Iron & Steel Mfg. Co. v. Seaboard Air Line Ry., 233 U.S. 261, 266, 34 S.Ct. 502, 504, 58 L.Ed. 949 (1914).
In this case, to allow the IRS to recover from the interpleaded funds statutory interest accruing during the pendency of this litigation would substantially prejudice Rainier. The IRS's interest apparently would eat up most, if not all, of the interpleaded funds. By itself, this would not be enough to warrant invoking equity in Rainier's favor; Rainier cannot seek the protection of equity from a result that is merely unpleasant. We note, however,...
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